Risk-Based SME Lending

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Risk-BasedSME Lending

• August 13 to 15, 2008
• Davao City

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Introductions

• Introduce trainers
• Introduce participants
• Leveling of expectations
• Introducing the course

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Risk-Based SME Lending

• 3 days seminar 8.30 am to 4.30 pm
• 19 sessions, with 4 actual cases
• Designed for banks and financial institutions
  involved in SME lending
• Student Handbook contains all handouts, notes and
  materials.

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Risk-Based SME Lending

• Session 1 Opening session
• Introductions
• Leveling of expectations
• Course objectives
• Course outline
• Methodology
• Rules of the game

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Common abbreviations

• BRR means Borrower Risk Rating
• FRR means Facility Risk Rating
• SBC Small Business Corporation
• PD Probability of Default
• LGD Loss Given Default
• CAMP Cash, Admin, Marketing, Prodn
• CR Current Ratio
• DSC Debt Servicing Capacity

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Basic definitions

• Credit risk - is defined as the risk a bank wont
  receive money lent and interest earned on its
  loans.
• Repayment of funds and accompanying interest must
  occur if a bank is to succeed. If the loan
  principle is not returned, the bank will quickly
  fail. If the bank does not receive interest
  earned, its failure will be slower, but just as
  sure.

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Basic definitions

• Risk-based - simply means the bank or financial
  institution has a systematic way of assessing,
  measuring and managing credit risks.
• Banks are in the risk management business they
  assess, assume and manage risk. Those that do it
  well succeed and prosper. Those that do not
  manage risk perform poorly and in some instances,
  fail .

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Biggest risk

• Biggest Risk of All out of the 4 or 5 major
  risks that a bank faces, it is CREDIT RISK which
  is the biggest. It comprise 80 of all risks.
• A bank which fails to manage its credit risks is
  doomed to fail. A Bank which manages its credit
  risks well is likely to become profitable and
  sustainable.

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Why risk-based

• Importance of doing risk-based lending. Why is it
  important?
• Better way of identifying and measuring risks in
  the SME businesses being financed

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Course objectives

• Learn about BRR and FRR system and tools
• Practice doing BRR rating on cases
• Identify key risks in businesses
• Learn about SBCs financing programs
• Learn how to design your own BRR and FRR system

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Course outline

• 19 sessions
• Introduce BRR and FRR
• Four actual SME cases
• Plenty of practice to hone skills
• Small group discussion

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Methodology

• Will use adult education techniques
• Case discussion method
• Ask questions anytime, please
• Quizzes every day final quiz at the end
• Attendance recording is a must
• Come on time.

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Rules of the game

• Sign attendance sheet daily.
• Ask questions if anything is unclear.
• Participate actively in group discussions
• Share your views and experiences.
• Respect the views of your peers.

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Rules of the game

• Do your best in the quizzes. Its an opportunity
  to test your learning.
• Bring your Student Handbook every day. Bring a
  calculator too.
• Certificate of Participation to be given to
  everyone who completes the 3 day seminar

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Session 2

• Why do pilots check their plane before taking
  off?
• Why do you think it is important to check the
  backgrounds and risks of business of borrowers?
• Potential problems may come if there is no proper
  credit assessment

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Global trend

• There is now a global trend for banks to
  carefully examine and measure borrower risks
  before a loan is disbursed. (This is in contrast
  to old traditional way of banking which relied
  heavily on collaterals).

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Risk rating

• Global trend in banking systematic risk
  assessment of borrower-clients
• Basel II endorses 2 tier approach BRR and FRR
• Basel II includes both qualitative and
  quantitative analyses
• BSP endorses and requires credit risk
  assessments could increase CAMELS rating of
  banks

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BRR introduction

• Quantitative and qualitative evaluations are used
  in BRR.
• Not a purely numerical exercise
• Human judgement is still very important

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BRR introduction

• BRR analyses should help in making credit
  decision of the bank whether a loan will be
  given to a borrower or not, and what conditions
  to impose.
• FRR analyses should help in making decisions on
  loan size, loan terms, loan pricing and
  conditions on collaterals.

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BRR introduction

• BRR makes use of a score card various aspects of
  the business are analyzed and given a score.
• Risks are identified as each component of the
  business is analyzed
• Total score is obtained
• BRR score translated to BRR rating Grade 1 to
  10. See Handbook page 18

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BRR introduction

• Four major components of the business are
  analyzed deeply
• C cash financials (50 weight)
• A administration (20 weight)
• M marketing (15 weight)
• P production (15 weight)

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BRR introduction

• Under C- cash / financials, 4 items are analyzed
• CR current ratio
• DER debt-equity ratio
• DSC debt-servicing capacity
• ARL accounts receivable level

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BRR introduction

• Under A- administration, 4 items are analyzed
• EOM experience of owners/ managers
• OHS owners health, age, succession
• FC financial capacity
• AB attitude to banks

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BRR introduction

• Under M- marketing, 2 items are analyzed
• Sales concentration of sales
• Growth increase of sales past 3 years

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BRR introduction

• Under P- production, 4 items are analyzed
• Supplier concentration of suppliers
• Inventory speed turnover
• Production service capacity
• Business location

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BRR introduction

• BRR ratings range from 1 to 10.
• Grade 1 is high-quality, excellent client very
  low risk involved
• Grade 10 is a very poor, bankrupt client
• Grade 5 is considered acceptable.
• Qualitative descriptions shown in Student Folder
• BRR User Guide is used in BRR rating exercise

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Basic definitions

• Loan delinquency
• Loan default
• Probability of default (PD)
• Loss given default (LGD)

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Will it be useful?

• What are the possible benefits to the banks?
• To the SMEs?
• To the economy?

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Session 3

• Introduce briefly how BRR rating is done using a
  first actual SME case
• SBC has developed a good BRR system
• BRR scorecard
• Groupings into 4 or 5 groups.

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BRR introduction

• Work in small groups.
• Introduce briefly the case
• Read the case briefly Appendix 9
• Work together in rating the borrower
• Question-and-answer portion

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Report back

• What is the BRR rating? Will you lend to this
  company?
• What risks did you identify?
• What loan covenants should you require or impose?
  
• Questionand-answer

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Session 4

• BRR and its links to various aspects and
  components of the bank.
• Banks faces many risks operational risks,
  liquidity risks, market risks, etc.
• But the biggest risk of banks is credit risk
• BRR will help screen out bad accounts and
  identify good and bad credit risks

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BRR User Guide

• SBC has developed a BRR User Guide found in
  Appendix 6.
• Brief explanations about the User Guide

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BRR introduction

• BRR is related to many things in the
  organization. They are
• Loan pricing
• Loan portfolio quality and overall profitability
• Intensity of loan monitoring
• Number and kind of loan covenants or conditions
• Loan loss provisioning
• Organizational structure
• Calculation of PD and LGD

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BRR and PD

• BRR is related to Probability of Default
• It is logical to think that a company with a high
  BRR rating (meaning high business risk) should
  have PD and higher loan loss provisions in the
  books of the bank, while a company with a lower
  BRR rating (lower risks) shall have a lower PD
  and loan loss provisions.

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FRR introduction

• What is FRR?
• Facility Risk Rating, where a tool is used to
  systematically assess the collateral or security
  being offered by the borrower as security for the
  loan. A bank should also conduct a risk
  assessment of the collateral and such an FRR
  rating complements the BRR rating.
• FRR factors should only affect the pricing of the
  loan and conditions but not the basic credit
  decision

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FRR and LGD

• FRR is directly related to LGD Loss Given
  Default. Why?
• The quality of the security or collateral being
  offered by the client as measured by an FRR
  rating will allow the bank to have a good
  estimate of the amount of monetary loss that may
  be suffered by the bank in case the client
  actually defaults. This is called LGD Loss
  Given Default.
• If the security is of high quality the LGF will
  be probably low, but if the quality is poor, then
  the LGF will be probably high.

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FRR introduction

• A FRR rating table provides clear guidance on how
  to rate a business using the collateral being
  offered as security for the loan.
• See the FRR rating table in the 113
• FRR rating of zero is very high quality
  collateral while an FRR rating of 10 means very
  poor or no collateral at all.

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Credit scoring

• Credit scoring is a statistical method used to
  predict the probability that a borrower will
  default.
• Statistical techniques assign weights to various
  borrower characteristics
• Past performance can predict future behavior.
• Credit scoring is another form of
  risk-management, but it is very difficult or
  nearly impossible to implement if there is no
  good client database, which should have at least
  10,000 cases, and collected over a period of 3 to
  5 years.

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Bangko Sentral

• The BSP requires all banks to put in place a
  credit risk management system.
• See BSP circular in Appendix 2
• Several BSP circulars released.

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Session 5

• Let us do a BRR rating of one actual SME company.
  
• A brief introduction to the case
• Work in small groups within time limit
• Report back

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Quiz No. 1

• Let us test ourselves and see how much new
  information we have obtained from this seminar.

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Homework

• Reflect on what we learn today and write in a
  piece of paper 1 or 2 questions to clarify things
  that are unclear.
• Read the 2nd case tonight, so we can save time
  tomorrow.